Cash Balance Plans

SOLUTIONS FOR BUSINESS OWNERS AND PARTNERS

What is a cash balance plan?

A cash balance plan is a type of defined benefit plan that resembles a defined contribution plan. For this reason, these plans are referred to as hybrid plans. A traditional defined benefit plan promises a fixed monthly benefit at retirement usually based upon a formula that takes into account the employee’s compensation and years of service. A cash balance plan looks like a defined contribution plan because the employee’s benefit is expressed as a hypothetical account balance instead of a monthly benefit.

Each employee’s “account” receives an annual contribution credit, which is usually a percentage of compensation, and an interest credit based on a guaranteed rate or some recognized index like the 30 year Treasury rate. This interest credit rate must be specified in the plan document. At retirement, the employee’s benefit is equal to the hypothetical account balance which represents the sum of all contribution and interest credits. Although the plan is required to offer the employee the option of using the account balance to purchase an annuity benefit, employees generally will take the cash balance and roll it over into an individual retirement account (unlike many traditional defined benefit plans which do not offer lump sum payments at retirement).

As in a traditional defined benefit plan, the employer in a cash balance plan bears the investment risks and rewards. An actuary determines the contribution to be made to the plan, which is the sum of the contribution credits for all employees plus the amortization of the difference between the guaranteed interest credits and the actual investment earnings (or losses).

Advantages

Employees appreciate this design because they can see their “accounts” grow but are still protected against fluctuations in the market. In addition, a cash balance plan is more portable than a traditional defined benefit plan since most plans permit employees to take their cash balance and roll it into an individual retirement account when they terminate employment or retire.

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Increased Savings for Physicians

One of our healthcare clients is an affiliated service group made up of a specialty clinic, surgery center and individual shareholder physician companies. They came to us with a 401(k) Profit Sharing Plan that allowed for deferrals up to the maximum dollar limit of $18,000 (or $24,000 for those age 50+), a Safe Harbor matching contribution of up to 5% of compensation and profit sharing contributions of 5.7% of compensation plus 5.0% of compensation in excess of the social security wage base ($118,500). Under this plan, physician shareholders were limited to contributions of $53,000 (or $59,000 for those age 50+).

401(k) Profit Sharing Plan  
401(k) $18,000 ($24,000 if age 50+)
Match $13,500
Profit Sharing $22,500
Total $54,000 ($60,000 if age 50+)

 

We designed a Cash Balance Pension Plan to be added to the group’s existing 401(k) Profit Sharing Plan to increase the amount shareholder physicians were able to put away for retirement. The existing 5.7% profit sharing contribution for employees allows each shareholder physician to have an additional cash balance contribution of $47,700. This resulted in an 89% increase in the total contributions for shareholder physicians from $54,000 to $101,700 (or from $59,000 to $106,150 for those age 50+).

Additional Cash Balance Plan
401(k) $18,000 ($24,000 if age 50+)
Match $13,500
Profit Sharing $22,500
401(k) Profit Sharing Plan Total $54,000 ($60,000 if age 50+)
Total Cash Balance $47,700
Grand Total $100,700 ($107,700 if age 50+)

We also proposed an increase in cash balance contributions for shareholder physicians over age 50 the following year by increasing the profit sharing contribution for employees to at least 7.5% of compensation. We provided this increase in profit sharing without increasing the amount of total employer contributions by eliminating the matching contribution. This change in plan design resulted in a potential savings of $136,100 for the employer. At the same time, it provided more than three times the cash balance contribution for shareholder physicians over age 50.

If you would like to learn more about whether a cash balance plan is right for your company, please contact David Strom, Director of Retirement Plan Services.